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Why do Companies go Public? An Empirical Analysis

Pagano, Panetta, and Zingales

Journal of Finance February 1998

Executive Summary

Italian firms wait longer than US firms before going public but appear to go public based on market-to-book values of their industry. Firms go public after a period of growth and investment. Firms pay a lower interest rate (even after controlling for leverage etc.) after the shares are public. Founder diversification appears to be a small factor in the decision as few sell shares.

As going public has many costs, it is worthy to determine why firms decide to go public. This paper looks at Italian firms that go public as well as their post public behavior to see what are the advantages. One of the driving forces behind this paper is the data availability for the Italian firms.

Background

In many countries (this paper notes Germany and Italy) firms do not go public as quickly as in the US. Further many do not go public at all. As a result, the size of equity market to GDP is lower than in the US. However, Italy is fairly representative of Continental European nations. A possible reason for the fewer public firms is that "minority shareholder rights" are less protected in these nations.

Data

Three main data sources:

1. Centrale dei Bilanci (the Italian Company Accounts Data Service) which "provides standardized data on the balance sheets and income statements of about 30,000 non financial firms." These firms account for 57% of nation's sales.
2. Centrale dei Rischi (Central Credit Register) which provides interest rates on bank loans.
3. IPO prospectuses.

To narrow the number of firms down, the authors look only at those firms that satisfy listing requirements and meet other requirements as well (such as non-financials, size, etc). The eligible list is then compared to the actual IPO sample.

(Note the IPO final sample is quite small, only "69 companies, of which 40 are new listings, and 29 are carve-outs.")

Summary statistics:

Table I compares the "whole sample" to those that are "eligible to go public" to those that actually do go public "the IPO sample." The significant findings are that those firms that do go public are larger, older, and more highly levered but not more profitable.

The median company is "about four times as large as the typical IPO in the United States in terms of sales. (Ritter 1991)

Competing Theories

The authors try to determine which of the many theories of IPOs is consistent with the actual data. (Table II)

1. Adverse selection-- moral hazard, and underpricing. Here the prediction would be that older firms would go public and larger firms as there would be lower asymmetries….[This was found to be true (at least for size).}
2. Administrative costs--Although the floating costs are cheaper than the US (7% Ritter vs. 3.5% in Italy), the fixed costs are comparable and hence the prediction would be that larger firms go public. [This was found to be true.]
3. Loss of Confidentiality--firms with high R&D would be less likely to go public. Unfortunately the authors do not have the data availability and thus to not test this.

1. Overcoming borrowing constraints. This can be tested with ex post data by determining whether "newly listed companies…increase their investments or reduce their debt exposure after the IPO." Further, if the constraint is the reason for the go public decision, then payout ratios are not likely to increase.

[This was found to be partially true: investment and leverage dropped.]

2. Greater Bargaining power with banks--would expect to see the concentration of bank loans to fall and the rate of interest to also fall.

[This was found to be true. Interest rates dropped and concentration as measured by the Herfindahl index also dropped]

3. Liquidity and portfolio diversification--this argument is based on the idea that current shareholders want to diversify their holdings. "Liquidity is an increasing function of their trading volume, so that this liquidity benefit may be effectively reaped only by sufficiently large companies." Further, "we should expect riskier firms to go public [where benefits of diversification would be greater] and controlling shareholders to sell a large portion of their shares."

[Except for the size prediction, these were not found to be true.]

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